Category Archives: Uncategorized
The U.S. Supreme Court heard oral argument in the Emulex case this week. The question presented focused on the mental state for securities claims alleging a misstatement in connection with a tender offer under Section 14(e) of the Securities Exchange Act. While most circuits have found that the required mental state is scienter (i.e., fraudulent intent), the Ninth Circuit decision below concluded that a finding of negligence is sufficient.
Much of the commentary, activity, and briefing in the case, however, was directed at a different issue. For many years, lower courts have found that there is an implied private right of action under Section 14(e). But is that correct under more recent Supreme Court precedents that have limited the creation of implied private rights of action?
As highlighted at the oral argument, however, it is not clear that the Court will be willing to take on an issue that was barely raised below and not directly presented to the Court. Five justices expressed skepticism (at least in their questioning) that the issue was properly before the Court, with Justice Sotomayor asking the petitioners whether considering it would be the equivalent of “rewarding you for not raising it adequately below, rewarding you for mentioning it in two sentences in your cert petition and not asking us to take it as a separate question presented?” Justice Alito, in his only question of the day, asked the government (appearing as amicus): “Could you explain why you think it’s appropriate for us to reach the question whether there’s a private right of action? If you were the Respondent here, would you think that that claim was properly before us? Is that the precedent you want us to set?” If the issue were to be decided, however, Chief Justice Roberts and Justice Gorsuch appeared to be the biggest proponents of the position that there is no implied private right of action for Section 14(e) claims.
On the other hand, the questioning suggested that there may be considerable support for a finding that scienter is the required mental state. Justice Sotomayor noted, in a point picked up by other justices, “that since 14(e) borrows the language of 10-5, and we have all along interpreted 10b-5 to require scienter, why shouldn’t we require the same standard here?” There also was discussion of the practicalities of the Court’s potential rulings. For example, Justice Kavanaugh asked the government whether “that’s caused real-world problems, recognizing the private right of action?” and later asked respondents “how would you assess SEC enforcement alone of a negligence standard versus SEC plus private enforcement of a higher mens rea standard?”
A decision should be issued by June 2019. A transcript of the oral argument can be found here.
Disclosure: The author of The 10b-5 Daily assisted the Washington Legal Foundation in the submission of an amicus brief arguing that there should be a uniform scienter standard for violations of Section 14(e) (misstatements in connection with a tender offer) and Section 14(a) (misstatements in connection with a proxy solicitation).
The U.S. Supreme Court has issued a decision in the Lorenzo v. SEC case holding that an individual who disseminates false statements to investors (even if the statements were made by someone else) can be primarily liable for securities fraud under Section 10(b) of the Exchange Act and SEC Rule 10b-5. It is a 6-2 decision authored by Justice Breyer.
In Lorenzo, the court addressed an action by the Securities and Exchange Commission (SEC) against the director of investment banking at a brokerage. Lorenzo sent e-mails to investors, the contents of which were provided to him by his boss, that he knew falsely touted a potential investment. In an administrative action, the SEC found that Lorenzo had violated Section 10(b) and Rule 10b-5 and, on appeal, the D.C. Circuit affirmed that ruling.
Before the Court, Lorenzo argued that his case should be governed by subsection (b) of Rule 10b-5, which specifically addresses misstatements. The Court – in its 2011 decision in Janus – had held that an individual who does not have “ultimate authority” over a misstatement is not its “maker” and cannot be primarily liable under subsection (b). Given that Lorenzo’s boss was the maker of the misstatements (which the SEC did not contest), Lorenzo concluded that he should not have faced primary liability for his actions.
Rule 10b-5, however, contains two other subsections. By their plain language, subsections (a) and (c) cover a wide range of potential conduct, including “employing” a “device,” “scheme,” or “artifice to defraud” and “engaging in any act, practice, or course of business” that “operates . . . as a fraud or deceit.” The Court found it “obvious” that “the words in these provisions are, as ordinarily used, sufficiently broad to include within their scope the dissemination of false or misleading information with the intent to defraud.” As to whether applying these subsections in a misstatements case would render subsection (b) “superfluous,” the Court concluded that the subsections are not mutually exclusive and any other conclusion “would mean those who disseminate false statements with the intent to cheat investors might escape liability under the Rule altogether.”
In a vigorous dissent, Justice Thomas (joined by Justice Gorsuch)), argued that the majority decision “eviscerates” the Janus distinction between primary and secondary liability. Justice Thomas noted that this will have a wide impact on the enforcement of the securities laws, because “virtually any person who assists with the making of a fraudulent misstatement will be primarily liable and thereby subject not only to SEC enforcement, but private lawsuits.” Moreover, this potential liability could extend widely to anyone who participates in the dissemination of misstatements, including administrative employees (secretaries, mail clerks, etc.).
Held: Judgment affirmed.
Quote of note: “Coupled with the Rule’s expansive language, which readily embraces the conduct before us, this considerable overlap suggests we should not hesitate to hold that Lorenzo’s conduct ran afoul of subsections (a) and (c), as well as the related statutory provisions. Our conviction is strengthened by the fact that we here confront behavior that, though plainly fraudulent, might otherwise fall outside the scope of the Rule. Lorenzo’s view that subsection (b), the making-false-statements provision, exclusively regulates conduct involving false or misleading statements would mean those who disseminate false statements with the intent to cheat investors might escape liability under the Rule altogether. But using false representations to induce the purchase of securities would seem a paradigmatic example of securities fraud. We do not know why Congress or the Commission would have wanted to disarm enforcement in this way.”
Note: The absence of aider and abettor liability in private actions alleging violations of Section 10(b) and Rule 10b-5 means that who can be subject to primary liability is a crucial question. Just as Janus resulted in significant litigation over who is a “maker” of corporate statements, Lorenzo is likely to lead to significant litigation over who is a “distributor” of corporate statements. Stay tuned.
Disclaimer: The author of The 10b-5 Daily assisted with the submission of an amicus brief by a group of law professors in support of the petitioner.
Plaintiffs frequently bring securities class actions arguing that the corporate disclosure of a regulatory issue has rendered earlier statements about regulatory compliance false or misleading. But are general corporate statements concerning regulatory compliance material to investors?
In Singh v. Cigna Corp., 2019 WL 1029597 (2d Cir., March 5, 2019), the Second Circuit addressed this issue. Following an audit by the Centers for Medicare and Medicaid Services (“CMS”), Cigna received a letter stating that it had “substantially failed to comply with CMS requirements regarding coverage determinations, appeals, benefits administration, compliance program effectiveness and similar matters.” After Cigna disclosed the letter and CMS’s proposed sanctions, its stock price declined.
The plaintiffs argued that these compliance issues rendered a number of prior Cigna statements false or misleading. In particular, Cigna had disclosed that it (a) had “established policies and procedures to comply with applicable requirements,” (b) had “a responsibility to act with integrity in all we do, including any and all dealings with government officials,” and (c) “expect[ed] to continue to allocate significant resources” to compliance.
The Second Circuit found that all of Cigna’s statements, however, were immaterial as a matter of law. The statements were “tentative and generic,” and, given that Cigna talked about allocating significant resources to compliance, “seem to reflect Cigna’s uncertainty as to the very possibility of maintaining adequate compliance mechanism in light of complex and shifting government regulations.” Accordingly, the court affirmed the dismissal of the plaintiffs’ claims.
Holding: Dismissal affirmed.
Quote of note: “This case presents us with a creative attempt to recast corporate mismanagement as securities fraud. The attempt relies on a simple equation: first, point to banal and vague corporate statements affirming the importance of regulatory compliance; next, point to significant regulatory violations; and voila, you have alleged a prima facie case of securities fraud! The problem with this equation, however, is that such generic statements do not invite reasonable reliance. They are not, therefore, materially misleading, and so cannot form the basis of a fraud case.”
NERA Economic Consulting and Cornerstone Research have released their respective 2018 annual reports on federal securities class action filings. As usual, the different methodologies employed by the two organizations have led to different numbers, although they both identify the same general trends.
The findings for 2018 include:
(1) The reports agree that filings continue to be at near-record levels, driven by a steady growth in “standard” filings alleging violations of Rule 10b-5, Section 11, and/or Section 12 and the continued shift to federal court of M&A-related cases. NERA finds that there were 441 filings (compared with 434 filings in 2017), while Cornerstone finds that there were 403 filings (compared with 412 filings in 2017).
(2) Both NERA and Cornerstone report that approximately 8% of publicly-listed companies were subject to securities class actions in 2018. While that is an all-time high, it also is a function of the fact that the overall number of publicly-listed companies has declined substantially over the last 25 years (the result of a combination of fewer IPOs and M&A activity).
(3) Filings against foreign issuers had steadily increased from 2013-2017, with these companies facing a disproportionate (as compared to their percentage of listings) risk of securities class action litigation. In 2018, however, both NERA and Cornerstone find a decrease in these filings, although the overall number of filings against foreign issuers (Cornerstone – 47; NERA – 43) remains high as compared to the historical average.
(4) NERA reports that, in 2013, 24% of filings alleging violations of Rule 10b-5 contained insider trading allegations. That percentage has dropped precipitously since 2013, with only 5% of last year’s filings containing insider trading allegations. NERA attributes the decline to the regulatory crackdown on insider trading and the increased corporate use of Rule 10b5-1 trading plans.
(5) NERA finds that the average settlement value for standard cases (excluding settlements over $1 billion) increased from $25 million (2017) to $30 million (2018). Meanwhile, the median settlement value for these cases increased from $6 million (2017) to $13 million (2018).
The Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) precludes any “covered class action” based upon state law that alleges a misrepresentation in connection with the purchase or sale of nationally traded securities. The defendants are permitted to remove the case to federal district court for a determination as to whether the case is precluded by the statute. If so, the district court must dismiss the case; if not, the district court must remand the case back to state court.
SLUSA has a bifurcated definition of “covered class action” for a single lawsuit. The action qualifies as a covered class action when (in relevant part) either (a) damages are sought on behalf of more than 50 persons or prospective class members; or (b) one or more named parties seek to recover damages on a representative basis on behalf of themselves and other unnamed parties similarly situated.
In Nielen-Thomas v. Concorde Investment Services, LLC, 2019 WL 302766 (7th Cir. Jan. 24, 2019), the Seventh Circuit considered whether a putative class action meeting all of the other requirements for SLUSA preclusion, but brought on behalf of “between thirty-five and forty-nine members,” should be allowed to proceed in state court. The plaintiffs argued that the two definitions of “covered class action” were “separate, independent bases for excluding securities class actions from SLUSA’s proscriptions” so that being excluded under one was sufficient, or, alternatively, the fifty-person threshold must apply to both definitions to avoid making the second definition superfluous. The Seventh Circuit disagreed.
The Seventh Circuit found that while there was an overlap between the two definitions, each had a separate meaning. Under the first definition, the action could “be treated as a class action even if all plaintiffs are identified in the complaint and no plaintiff is pursuing claims as a representative on behalf of others, if there are more than fifty such plaintiffs and SLUSA’s other requirements are met.” The second definition, in contrast, “includes any action brought as a putative class action in the traditional Rule 23 meaning of the term.” The Seventh Circuit also found that this interpretation is consistent with SLUSA’s purpose and legislative history, noting that Congress wanted to prevent plaintiffs from circumventing the barriers to federal securities class actions by simply filing them in state court (no matter how large the size of the class). Because the case before the court clearly was a putative class action, it fell within the second definition and was precluded.
Holding: Dismissal affirmed.
Quote of note: “To the extent the identities of any of the other putative class members are known, and these individuals wish to pursue claims on their own behalf in state court under state law, nothing in SLUSA prevents them from doing so (provided there are fewer than fifty such plaintiffs for which common questions of law or fact predominate). What SLUSA does preclude these individuals from doing is continuing to pursue their claims in the form of a class action.”
After fifteen years of publishing The 10b-5 Daily, it was good to take a short sabbatical! But with the new year, this blog is back up and running. So let’s get to it.
On Friday, the U.S. Supreme Court granted certiorari in Emulex Corp. v. Varjabedian, setting up a battle over actions brought under Section 14 of the Securities Exchange Act.
In its petition, Emulex presented the following question:
Whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.
The direct question presented is a narrow dispute over the Section 14(e) state of mind requirement – i.e., does a private plaintiff need to show that the defendant acted with negligence or scienter (i.e., fraudulent intent)? That said, there are a few ways the case could have a broader impact.
First, although the question presented refers to a “private right of action,” any determination as to the required state of mind also would apply to actions brought by the government.
Second, there is a related statutory provision – Section 14(a) – that addresses misstatements or omissions made in connection with proxy solicitations. The state of mind requirement for actions brought under Section 14(a) also is the subject of a circuit split and may be impacted by the Court’s decision.
Finally, there is some question as to whether there should be an inferred private right of action under Section 14(e) at all (despite the fact that a number of lower courts have found that one exists). In its amicus brief filed in support of the cert petition, the U.S. Chamber of Commerce argued that the Court should address this threshold issue and find that only the government can bring an action to enforce Section 14(e).
In Halliburton II, the U.S. Supreme Court held that defendants can rebut the fraud-on-the-market presumption of reliance at the class certification stage with evidence of a lack of stock price impact. There are at least two different points, however, when stock price impact might be relevant: (a) the date of the alleged misstatement, and (b) the date of the alleged corrective disclosure. Is it enough for defendants to provide evidence of a lack of stock price impact as of the date of the alleged misstatement?
In In Re Finisar Corp. Sec. Litig., 2017 WL 6026244 (N.D. Cal. Dec. 5, 2017), the plaintiffs alleged that a December 2010 statement misled investors as to the nature of Finisar’s growth by denying that the company’s revenue increase was the result of an unsustainable inventory build-up by customers. The complaint also stated that Finisar’s stock price increased after the statement was issued.
At class certification, the defendants presented an expert report demonstrating that any increase in Finisar’s stock price following the alleged misstatement was not statistically significant “when the price is adjusted for general market and industry trading.” Among other objections, the plaintiffs asserted that the expert report was “flawed insofar as it fails to consider Finisar’s stock price change following the allegedly corrective disclosure” that occurred several months later. The court acknowledged that for purposes of price impact analysis, many courts have focused on the corrective disclosure date, especially where there may have been offsetting disclosures about the company on the date of the alleged misstatement or the plaintiffs had alleged that the misstatement maintained the stock price at an artificially-inflated level. (For more on the “price maintenance theory,” see here and here.)
In the instant case, however, the court found that neither of those rationales for focusing on the corrective disclosure date were applicable. There was no evidence that other information about Finisar had offset any price inflation caused by the alleged misstatement and the plaintiffs were not proceeding on a price maintenance theory. Under these circumstances, the court found no flaw in the expert analysis “simply because it focuses on the date of the alleged misstatement rather than the date of the alleged corrective disclosure.”
Holding: Class certification denied.
On Tuesday, the U.S. Supreme Court heard oral argument in the Cyan, Inc. v. Beaver County Employees Retirement Fund case, which addresses the preemptive scope of the Securities Litigation Uniform Standards Act of 1998 (SLUSA). At issue in the case is whether SLUSA divests state courts of jurisdiction over class actions asserting claims arising under the Securities Act of 1933 (e.g., claims alleging a material misstatement in a registration statement).
The question before the Court is closely tied to Congress’s intent in enacting SLUSA. In 1995, Congress passed the Private Securities Litigation Reform Act (PSLRA) to protect corporate defendants from meritless securities class actions. The PSLRA, however, only applied to federal cases. To evade the PSLRA’s impact, plaintiffs began filing securities class actions in state court, usually based on state law causes of action.
Congress passed SLUSA to close this loophole. Due to unclear drafting, however, there has been confusion in the lower courts over whether SLUSA also makes federal court the sole venue for class actions alleging Securities Act claims (which historically enjoyed concurrent jurisdiction in state or federal court). In Cyan, the parties have put forward three competing interpretations of SLUSA. The Petitioners (Defendants) contend that SLUSA divests state courts of jurisdiction over class actions asserting Securities Act claims, thereby insuring that those cases must be litigated in federal court. The Solicitor General maintains that SLUSA permits the removal of class actions asserting Securities Act claims, thereby also allowing those cases to be heard in federal court. Finally, the Respondents (Plaintiffs) contend that SLUSA did not address class actions asserting Securities Act claims at all, meaning that once in state court they are not removable to federal court.
The parties’ textual arguments require having SLUSA in one hand and a yellow highlighter in the other. In the end, however, the text of the statute might not end up having much sway over the Court. The justices expressed varying degrees of frustration in trying to parse through the specific statutory language to reach a result, with Justice Alito, in particular, repeatedly referring to the relevant provisions as “gibberish” and noting that “all the readings that everybody has given to all of these provisions are a stretch.”
Petitioners and the Solicitor General appeared to have more success on the issue of Congressional intent. Petitioners’ counsel drew an analogy to building a house, suggesting that it was nonsensical to believe that Congress would have barred the front door against the bringing of securities class actions in state court asserting state law claims, while simultaneously leaving the back door open for plaintiffs to bring securities class actions in state court asserting federal law claims. Moreover, if securities class actions asserting federal law claims go forward in state court, they are not subject to the PSLRA’s procedural protections, a result that Congress presumably wanted to avoid.
Several justices picked up on this theme, with Justice Ginsburg asking Respondents’ counsel “why would Congress want to do that” given that you end up with “the federal claim in state court, and none of those [PSLRA] restrictions apply”? Similarly, Justice Alito expressed incredulity that Congress would want to bar “a claim in state court under a state cause of action that mirrors the ’33 Act” but then allow “the state court to be able to entertain the real thing, an actual ’33 Act [claim].” Respondents’ counsel answered that if Congress was concerned about the “evasion of the PSLRA” in securities class actions alleging Securities Act claims, there were “10 different easier ways and more clear ways” that it could have removed the existence of concurrent jurisdiction for those cases (but it did not). Justices Kagan and Sotomayor appeared sympathetic to that position, with Justice Kagan noting that “Congress did everything it wanted with respect to actions [under the Securities Exchange Act of 1934], which are the lion’s share of securities lawsuits.”
A decision is expected sometime early next year.